The Board’s Importance in Vetting Shareholder Proposals

A recent successful effort by a public company to exclude an environmental proposal from its proxy statement may signal a new approach for boards of directors to consider when managing shareholder proposals. Because retailers and consumer products companies routinely receive shareholder proposals on environmental and sustainability issues, similar arguments for exclusion may be persuasive to the staff of the Securities and Exchange Commission (SEC) in the future.

Activist shareholders have made use of SEC Rule 14a-8 to force shareholder referenda on all manner of issues, with those dealing with environmental, social and governance issues among the most popular. Rule 14a-8 provides that any shareholder who has continuously held at least $2,000 in market value or 1 percent of a public company’s common stock for at least one year can submit a proposal for inclusion in a public company’s proxy statement, subject to certain exceptions and exclusions. While such proposals rarely receive majority support once ballots are tallied, they nonetheless have become a popular advocacy tool for environmental activists and other special interest groups seeking to effect broad change at public companies, including retailers and consumer products companies.

When a public company receives an eligible shareholder proposal, it has four options: (1) include the proposal in the proxy statement; (2) negotiate with the proponent to secure a withdrawal; (3) seek a ruling on the proposal’s propriety in federal district court; or (4) seek an interpretive ruling from the SEC staff, known as a no-action letter, that the company may exclude the proposal. Litigation is an expensive and rarely utilized option, so companies desiring to exclude a proposal for which a negotiated withdrawal is unobtainable usually petition the SEC staff for a no-action letter. The process is a highly technical one. Whether the SEC staff will permit a proposal to be excluded often turns on subtle nuances in wording in the proponent’s resolution and supporting statement.

One of the widely used grounds for excluding a shareholder proposal is the ordinary business exception. Rule 14a-8(i)(7) allows a company to exclude a shareholder proposal that deals with matters that are “so fundamental to management’s ability to run a company on a day-to-day basis that they could not, as a practical matter, be subject to direct shareholder oversight.” Proposals that focus on “sufficiently significant” policy issues that transcend ordinary business, however, may not be excluded under this exception.

In the past, the SEC staff has conducted its own analysis to determine whether it believes a shareholder proposal is “sufficiently significant.” Two recent SEC Staff Legal Bulletins, SLB 14I and SLB 14J, place more responsibility on boards, stating that “the board of directors is generally in a better position to determine” these “difficult judgment calls.”

On March 13, 2019, SEC staff issued a no-action letter to MGE Energy permitting it to exclude a shareholder proposal that requested a report “describing how [the company] can provide a secure, low-cost energy future for their customers and shareholders by eliminating coal and moving to 100% renewable energy by 2050 or sooner.” MGE sought to exclude the proposal under Rule 14a-8(i)(7) because it related to the company’s ordinary business operations. The staff agreed, finding that “the Proposal seeks to micromanage the Company by seeking to impose specific methods of implementing complex policies in place of management as overseen by its board of directors.” Reliance on the board’s analysis seems to be a critical component of the staff analysis.

In its original no-action request, MGE sought to exclude the proposal under Rule 14a-8(i)(7) for three main reasons. First, MGE argued that the proposal sought to micromanage the company by requiring shareholder involvement in determining the kind of technologies the company must utilize to meet an arbitrary time frame of 2050. Additionally, MGE argued that the proposal failed to transcend day-to-day operations of the company. The company acknowledged that the proposal dealt with an important policy issue, but argued it should still be excluded because it sought to impose a quantitative, time-bound target that would require management to abandon its judgments on company business.

Most notably, MGE noted in its request that its board of directors had considered the proposal in conjunction with MGE’s existing policies and found that it was not in the best interest of the company. The letter named several additional considerations the board took under advisement when considering the proposal. After conducting a “complex and thoughtful analysis,” the board ultimately concluded that the proposal was not in the best interest of the company or its shareholders.

In a response letter on February 1, 2019, the proponents urged the SEC staff to reject MGE’s arguments that it could exclude the proposal under Rule 14a-8(i)(7). The proponents argued that because it involved climate change, an important social issue that transcended day-to-day business, the proposal did not micromanage the company. Proponents also argued the proposal transcended the day-to-day business of the company because it set a specific long-term goal related to a significant policy issue to which the company must respond. They cited various jurisdictions and major events throughout the United States that highlighted the “urgency of the issue of decarbonization.” Moreover, the proponents rejected the company’s use of the board’s analysis, calling it “irrelevant.”

In a subsequent response to the SEC staff, MGE contested the proponents’ assertion that the board’s conclusion was irrelevant to the staff’s decision. The company pointed to Staff Legal Bulletin 14I, which calls for a consideration of “whether the company has already addressed the issue in some manner,” including considering the differences “between the proposal’s specific request and the actions the company has already taken.” The company argued that the board’s analysis was relevant to this question because the company already had implemented environmental and sustainability goals for 2050, which the board considered in its determination that the “proposal did not present a significant policy issue to the Company.” MGE also pointed to SLB 14J, noting that the company’s shareholders voted on a nearly identical proposal by the proponents in 2018, which received minimal support, a key factor in evidencing that rank-and-file shareholders had little interest in the matter. In its conclusion, the company asked the staff to reject the proponent’s characterizations of the proposal and allow for its exclusion under Rule 14a-8(i)(7) for the same reasons it articulated in its original letter.

Although the staff’s response letter permitting MGE to exclude the proposal is terse (as is customary), the following language is critical to understanding the staff rationale: “[T]he Proposal seeks to micromanage the Company by seeking to impose specific methods of implementing complex policies in place of management as overseen by its board of directors.”

For various reasons, very few other companies seeking no-action relief have sought to provide a detailed board analysis of a particular shareholder proposal under the ordinary business exclusion. While the SEC staff has clarified that such an analysis is not required, by providing a detailed summary of the board’s deliberations the MGE experience provides a roadmap to other boards of directors considering the propriety of similar proposals, in both the kinds of matters to deliberate and how to present those deliberations to the SEC staff.

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